steve321 wrote: ↑
Thu Oct 11, 2018 12:00 am
nisiprius wrote: ↑
Wed Oct 10, 2018 5:58 pm
If by "hedge" you mean a way of getting the returns of stocks without really taking the risks of stocks, if you mean some magic investment that will simply cancel out stock plunges, I think that's the investing equivalent of perpetual motion.
By hedge I mean something with a low or negative correlation to stocks.
Low correlation isn't a hedge at all. Zero correlation isn't a hedge at all. The benefits of low correlation are subtle and hard to understand--basically, honors student in high school math--so they are "explained" with misleading language and explanations.
My understanding is that when stocks take a dive, there's generally a flight to safety, which makes bonds go up.
Your understanding is seriously flawed and you need to take a look for yourself at what really has happened
1) The correlation between stocks and bonds has been close to zero, not negative
. Some negative correlation has been observed over the last decade or so but I wouldn't bank on it.
2) Not all bonds have shown the "flight to safety" effect. The mixture of bonds in the Vanguard Total Bond Market Index Fund, for example, is almost a straight line during the period of the 2008-2009 stock crash. No dip, no bulge. Investment-grade corporate bond funds took a 10% hit. The "flight to safety," if that is really what has been occurring, has been pretty well limited to Treasuries.
3) Most important, the "flight to safety" effect has been weak
. During 2008-2009, if you'd been in an intermediate-term Treasury fund instead of Total Bond, you'd have seen a little 6% or 10% bulge (depends how you measure). But you would have paid for this, over history, with a noticeably lower return. And it was only 10%.
Blue, total bond. Orange, intermediate-term Treasuries. Green, stocks.
That's about as good an example of a "flight to safety in Treasuries" working, and certainly it's nicer to have a +10% gain than a -50% loss, but that's not much of an offset.
You can get more by going to long-term bonds but that has serious problems of its own
, specifically inflation risk.
I just consider bonds as a sea anchor, and that seems valid. In order to treat them seriously as a "hedge" that will counteract
stocks and not just dilute them, you would need to be holding a portfolio in the neighborhood of 15/85 or 20/80 to get a portfolio without much drop in 2008-2009. Of course, some investors really do this
, it's part of a risk parity strategy, but that comes a long with a ton of other
baggage, including a lot of leverage to make up for the low return of bonds.
And all this assumes that the negative correlation isn't just a chance sampling accident and that it will continue into the future.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.